Private Equity vs. China

How the Commerce Dept. crackdown on Chinese paper exports will help Cerberus

Capital and friends

It's hard to think of an American product that's less strategically important than the coated paper that magazines, annual reports, catalogs, and auto-dealer brochures are printed on. Yet there was Commerce Secretary Carlos M. Gutierrez, on Mar. 30, announcing tariffs on coated-paper imports from China—the first time in at least two decades that U.S. antisubsidy law has been applied to that country. By acting against unfair China trade, he said, the U.S. was standing up for "American manufacturers, workers, and farmers."

But Gutierrez left out one important group of beneficiaries: private equity investors. It turns out the paper manufacturer that brought the complaint, NewPage, is owned, through several levels of intermediaries, by New York-based Cerberus Capital Management, the mammoth private investment group controlled by the wealthy and reclusive Stephen A. Feinberg. Another big industry player, Verso Paper, is majority-owned by affiliates of private investment firm Apollo Management.

Buying Protection—From Cheap Capital

The government action raises obvious questions about the political influence of private investment firms, especially since the chairman of Cerberus, John W. Snow, served as President George W. Bush's Treasury Secretary from February, 2003, to July, 2006. But Cerberus says Snow didn't make phone calls on NewPage's behalf. And Cerberus has investment interests far beyond coated paper—Snow recently toured China calling for closer business cooperation between that country and the U.S.

But in a broader sense, what's going on is nothing less than a showdown between two very different ways of financing business. On the one side is China, which is accused of lowering the capital costs of coated-paper makers through subsidies such as low-cost loans and debt forgiveness. On the other side are the private money outfits, which raise huge funding pools by promising investors high returns in a low-return world.

The trade sanctions—which the Commerce Dept. could still back away from—would protect private equity-owned paper mills from China's cheap capital and help private investors realize the high returns they want. This battle of financial systems may be a harbinger of the next wave of trade disagreements.

How did we get into this situation? Over the past couple of years, U.S. paper giants such as MeadWestvaco (MWV) and International Paper (IP) wanted to shed some of their laggard divisions. They found ready buyers in the private equity firms, which saw a good deal.

In particular, in early 2005, MeadWestvaco sold its coated-paper mills and other assets to NewPage for $2.1 billion. The newly formed company took on about $1.8 billion in debt to finance the purchase. A Cerberus-owned affiliate tossed in $415 million in equity, according to documents filed with the Securities & Exchange Commission. (Disclosure: The same documents list The McGraw-Hill Companies (MHP), the parent company of BusinessWeek, as one of NewPage's biggest customers.)

Chinese Locomotive

This leveraged buyout left NewPage with big debts and hefty interest payments totaling $165 million in 2006, roughly double the size of its $88 million in capital expenditures. Such heavy debt makes it harder for the company to compete against the Chinese, as well as big European paper manufacturers. NewPage filed the complaint against the Chinese in October, 2006, about 18 months after Cerberus took over. This was the first time since 1991 that any company had formally filed such a complaint against a nonmarket economy.

Now, the fact that NewPage is owned by a private investment firm doesn't make the trade sanctions wrong. Indeed, the big paper makers may have sold off their businesses in part because they saw the onrushing Chinese locomotive of cheap coated-paper exports, which have soared from $21 million in 2004 to $224 million in 2006. The trade sanctions, if they stick, could help preserve the more than 4,000 jobs at NewPage, many in economically depressed areas of the U.S.

And it can be argued that China is at the point where such subsidies are unacceptable, just as capital subsidies to Airbus and Boeing (BA) are unacceptable for Europe and the U.S. "Our view is very simple," says Mark A. Suwyn, NewPage CEO. "We will compete with anybody in the world if it's fair. China can't join the WTO and then choose to use my country as a dumping ground. That's illegal."

A lot of people who worry about the rising tide of Chinese imports agree with Suwyn. But would they want to start a trade war with China to protect private equity investors?